Why do countries with strong legal protections for tenants have high proportion of renters, Economist?

#15 – Present photography meets future economics

P: Good morning, Economist. 

E: Good morning, Photographer. 

P: Do you remember our conversation about high rents the other day?

E: I do. Why do you ask?

P: Someone overheard our chat and asked me the following question afterwards: How is it that those countries with the highest proportion of renters versus homeowners, like Switzerland or Germany, have very strong legal protections for tenants?

E: I guess our listener thinks that strong tenant protection prevents landlords from offering living space, and therefore, the proportion of tenants versus homeowners should be lower.

P: I think so. But obviously, it isn't so. Why?

E: Theoretically, a high level of tenant protection speaks for neither a high nor a low share of tenants. Here is why. A high level of tenant protection increases the demand for rental apartments but reduces the supply of rental apartments. If, in contrast, tenant protection is low, the opposite is true: the supply of rental flats increases while demand decreases. It is, therefore, unclear what the effect of strong tenant protection on the proportion of people who live in rented accommodation is.

P: Too bad. 

E: But another consideration might help here. From the moment they move into a rental property, tenants are in a vulnerable position relative to the landlord. Because they have high costs when they end the tenancy. They have to look for a new apartment and manage the relocation. That costs a lot of time and money. Without strong tenant protection, landlords would tend to exploit this power imbalance. Because tenants take this into account when considering whether to rent or buy, the number of people renting would be lower if tenant protection were weak.

P: I understand that, Economist. What I still don't understand is why so few people buy their own homes. Someone who rents pays 100 per cent of the cost to the landlord. By purchasing, you have to pay the mortgage, but by paying back, you are building up wealth. In the end, the property is your own. 

E: I don't share your opinion that it makes more economic sense to buy than rent. If that were the case, the question would arise why so many people make economically unwise decisions. Your statement that you invest in your assets when paying off the mortgage is accurate but does not fully illuminate the topic.

P: There's more coming, right?

E: Here is a simple example. An apartment is bought for 100,000 Euro. The monthly mortgage payment is 1,000. There is no interest in this simplified world. So the condo will be paid off after 100 months, right?

P: I'm still in.

E: In comparison, a tenant who pays 500 Euro rent per month. They can invest another 500 Euros. Since there is no interest here, he will have saved 50,000 Euro after 100 months. So, I ask you Photographer, after 100 months, who is richer, the tenant or the homebuyer? 

P: I suppose it depends on the then current value of the apartment.

E: Right. If the value of the apartment is over 50,000 Euro, the apartment owner is wealthier, if it is less, the tenant is.

P: The apartment probably won't have lost half its value after 100 months, right?

E: Maybe. But we haven't added the interest rate to our example yet. Then the scales move in the direction of the tenant. Because the landlord can hardly influence the value of the apartment. The asset type is predetermined, as is the location. On the other hand, the tenant can use the money they save where it will grow best. Conclusion: The return on the tenant's investment probably outperforms the investment of the apartment.

P: I sometimes think that you economists are reluctant to commit yourself.

E: We economists simply consider several aspects. And we believe that people usually make the best decisions for themselves. If about half of the people rent their homes and the other half own their homes, it is not wise to think that half is doing something fundamentally wrong.

P: I like that thought. It shows respect for people in a way.

E: In that sense, have a respectable day, Photographer.

P: Have a nice day too, Economist.